PG&E’s path forward: to bankruptcy and beyond

06 June 2019

It has been more than five months since Pacific Gas & Electric (PG&E) commenced its Chapter 11 cases and, although some progress has been made, the company’s future and path forward is still largely uncertain. Wildfire liabilities continue to mount, California Governor Gavin Newsom is putting pressure on shareholders, and the California Public Utilities Commission (CPUC) and others are looking to the state legislature for a solution. Not to mention PG&E’s USD 17.5bn of unsecured noteholders, a group of which has proposed a USD 45bn plan to get the company out of bankruptcy, and, most likely protect their investment in the company. In this report, the Debtwire legal analyst team updates subscribers on the latest developments in the case and the legal, regulatory and legislative challenges the company faces as it looks towards an exit from Chapter 11.

Non-exclusivity extension

When PG&E commenced its bankruptcy cases on 29 January, it estimated that its stint in Chapter 11 would last at least two years, maybe three. This is likely because the case is fraught with complicated legal issues with no easy solutions. Moreover, the number of parties with a seat at the negotiating table has increased to include not only the CPUC, but the Governor of California, the state legislature, an official committee of unsecured creditors, an official committee of tort claimants, two bondholder groups, a shareholder group, power purchase agreement (PPA) counterparties, and various other ad hoc groups representing wildfire-related claimants.[1]CLICK HERE for more detailed information concerning each of these groups in Debtwire’s Restructuring Database (access required).

PG&E’s original time estimates have appeared to hold true given the contentious nature of the case thus far. Indeed, PG&E has faced opposition to nearly every motion it has filed including its USD 5.5bn in debtor-in-possession financing, employee incentive plan, USD 105m wildfire fund, and bar date motion, among others.[2] The bankruptcy case has also spawned five adversary proceedings and a parallel proceeding before the Federal Energy Regulatory Commission (FERC) regarding which overseer — FERC or the bankruptcy court — has jurisdiction over whether PG&E can reject certain of its PPAs in bankruptcy.

Perhaps the most significant dispute, or at least the one with the most ramifications for PG&E’s future, is related to its request for a six-month extension to its exclusive right to file a plan of reorganization. Such an extension, which debtors are free to request until a mandatory 18 month cutoff, is frequently granted as a matter of right in a bankruptcy case without a strong case for opening up the process of strategizing an exit to all stakeholders and potentially igniting a competing plan process.

Well, not always. PG&E faced an onslaught of objections to its motion to extend this deadline that argued, among other things, that PG&E needs to be put on a short leash and held accountable every step of the way. The most vehement objection came from the party that is likely to be the biggest thorn in PG&E’s side during the bankruptcy — the official tort claimants committee. The tort committee alleged that PG&E “refuses” to consider a plan of reorganization that does not include a bailout from the state of California and higher rates for ratepayers or a plan that leaves equity interests impaired or wiped out because the major shareholders currently have control of the board of directors.[3] Note that the CPUC has recently proposed establishing an advisory panel to evaluate PG&E board members and their adherence to safety protocol. The tort committee also questioned PG&E’s solvency and argued that the company should move their focus to a plan that pays creditors, including tort claimants, in full rather than protecting equity interests.

Below is a valuation and waterfall analysis prepared by Debtwire’s credit research team as part of its PG&E 1Q19 Credit Report.

The creditors the tort committee is referring to would include PG&E’s USD 17.5bn in unsecured noteholders, who have remained front and center during PG&E’s bankruptcy case. An ad hoc group of these noteholders has recently come forward with the framework for a plan of reorganization valued at over USD 45bn. Although the details of the plan have not been publicly disclosed, reports have indicated that the plan would recapitalize PG&E and establish a new statewide wildfire liability fund to compensate wildfire victims. The plan reportedly improves on an earlier proposal from the group that included a USD 14bn cash trust to pay claims tied to the 2017 and 2018 wildfires, a USD 13bn statewide wildfire fund to be financed by PG&E and other California utilities, and USD 8bn in cash to refinance the company’s USD 5.5bn DIP facility and other maturities. The group is led by Pacific Investment Management, Elliott Management and Davidson Kempner and its members and holdings as of 5 March are below.

The bondholder group may have its chance sooner rather than later to put its plan before the court and the creditor group as a whole as Judge Montali only granted PG&E a four-month exclusivity extension, which may signal his unwillingness to entertain further extensions absent creditor support. Thus, the gates have been opened to a competing plan situation involving PG&E, the ad hoc bondholder group and others. Note that this scenario is a familiar one for PG&E and Judge Montali as PG&E’s prior bankruptcy involved competing plans from PG&E on the one hand, and the CPUC and the unsecured creditors committee on the other. Although the parties ultimately agreed on a single reorganization plan that was confirmed by the court, the plan process took more than two years from the time PG&E proposed its original plan of reorganization in September 2001 to the time Judge Montali confirmed the plan in December 2003. A lengthy and contentious process indeed and one that we may see repeated in PG&E’s most recent Chapter 11.

Strike forces and blue ribbons

Although we do not yet know what role the ad hoc bondholder group will play in a post-bankruptcy PG&E, we do know three parties that are certain to have a hand in shaping PG&E’s future — the Governor of California, the state legislature and the CPUC — specifically regarding how to handle PG&E’s current and future wildfire liabilities. To that end, there are two recent reports to take note of that advance certain ideas that could lay the groundwork for PG&E’s Chapter 11 plan: (i) Governor Newsom’s Strike Force Report; and (ii) California’s Blue Ribbon Commission Report.

Strike Force Report

In February 2019, California Governor Gavin Newsom appointed a “Strike Force” made up of bankruptcy lawyers and financial advisors to develop a comprehensive strategy to address the growing wildfire threat to the state’s utilities. On 12 April, the Strike Force released its report and recommendations that were centered around the creation of two state wildfire funds — a liquidity-only fund and a catastrophic wildfire fund — and modifying the law of inverse condemnation, under which a utility can be held liable for damages, even if it followed proper safety procedures.

In terms of the funds, the liquidity-only fund would provide bridge financing for utilities to address the delay between when a utility pays wildfire claims and when the CPUC makes its determination regarding whether and how much the utility can recover through rate increases. The capital for the fund would come from utility investors and ratepayers. With the fund, the Strike Force is also recommending the modification of the cost recovery standards from the CPUC which the Strike Force believes would stabilize the credit ratings of utilities. This would involve statutory changes to clarify both the “prudent manager standard,” which is the standard a utility is required to meet in order to pass costs on to ratepayers, and the burden of proof related to when a utility is permitted to recover costs and expenses of wildfires from its customers. If the CPUC determines that the utility meets the revised cost recovery standard, then the utility would charge ratepayers the amount it had expended from the fund. If the CPUC determines that the utility did not meet the cost recovery standard, then the utility itself must reimburse the fund for the amounts drawn.

The second proposed fund, the catastrophic wildfire fund, would provide utilities with a source of immediate funding for claims asserted against them in connection with catastrophic wildfires such as the October 2017 and 2018 wildfires. The caveat here is that the fund would only be able to achieve its goal if utility shareholders were prepared to make a substantial contribution to the fund’s claims-paying resources and if insurers were willing to accept a cap on their subrogation claims. This is a pretty big caveat given that such catastrophic wildfire claims could be in the hundreds of millions or even billions of dollar range, meaning that equity holders could be asked to cough up a large amount of money for claimants that, at least in PG&E’s bankruptcy, are asking for payment in full on their claims.[4]

As far as what a reorganized PG&E may look like, the report notes that no options can be taken off the table, “including municipalization of all or a portion of PG&E’s operations; division of PG&E’s service territories into smaller, regional markets; refocusing PG&E’s operations on transmission and distribution; or reorganization of PG&E as a new company structured to meet its obligations to California.”[5]

Blue Ribbon Commission Report

On 29 May 2019, a commission of experts jointly appointed by the California legislature and Governor Newsom pursuant to SB 901, which was the legislature’s ill-fated attempt at protecting PG&E from having to file for bankruptcy as a result of the October 2017 wildfires, issued their report and recommendations on how to manage the long-term costs and liabilities associated with utility-caused wildfires. The report echoes many of the proposals outlined by the Strike Force such as replacing inverse condemnation with a fault-based standard, clarifying the CPUC’s cost recovery guidelines and setting up insurance-like funds for both wildfire victims and utilities. Where they differ is that the Blue Ribbon Commission recommends that each of these elements be considered together and that the cost recovery guidelines and parameters of the wildfire fund vary depending on whether the legislature reforms inverse condemnation and certain other factors. In addition, the wildfire fund proposed by the Blue Ribbon Commission would be capitalized by contributions from ratepayers, utility shareholders, property owners, as well as the State of California. The framework is largely the same as the Strike Force’s recommendations, with a key difference being asking California to also contribute funding.

One of the more notable elements of the report is that the Commission states that the very legislation that provided for its formation in the first place — SB 901 — is not working and does not do enough to manage the risk from wildfires to utilities like PG&E. SB 901 was passed at the end of August 2018 as a means of protecting PG&E from its potentially massive liabilities stemming from the October 2017 wildfires. The bill provided for three key measures: (i) that each California utility adopt wildfire mitigation plans; (ii) a clarification to the cost recovery process at the CPUC; and (iii) incorporation of a “stress test” to help guide the CPUC in determining how much of a financial loss the utility can withstand. Both the Strike Force and the Blue Ribbon Commission noted that the passage of SB 901 led to immediate credit rating downgrades and, as we all know, PG&E was still forced to file for bankruptcy five months later. As further evidence of the fact that SB 901 is not working, the CPUC recently issued a decision saying that it is not even able to apply the stress test methodology to bankruptcy utilities like PG&E. This would have, in theory, allowed PG&E to pass on some of its 2017 wildfire costs to ratepayers.

The bottom line, according to the Commission, is that new legislation is needed to address these problems.

Knocking on the legislature’s door

Governor Newsom appears to have taken some but not all of these recommendations. Following the Blue Ribbon Commission’s report, he issued a statement with Senate President pro Tem Toni Atkins and Speaker of the Assembly Anthony Rendon that they would be pursuing legislation to “seek equitable resolution on the prudent manager standard, bridge financing and to allow cost recovery for electricity providers who act responsibly and in the public’s best interest.” Off the table, at least for now, is any reform of inverse condemnation. Governor Newsom challenged legislators to pass these reforms before 12 July, when lawmakers take a month-long summer recess.

On the table and currently before the Senate is AB 740, which appears to follow the recommendations outlined by the Blue Ribbon Commission and the Strike Force. The current version of AB 740 provides for the creation of a California Catastrophic Wildfire Victims Fund “to ensure that victims of catastrophic wildfires are compensated in a timely manner, to provide reimbursements to victims for a portion of those wildfire losses, and to avoid lengthy legal proceedings.” The source of funding is unclear but is said to include “the State Budget process.” Utilities and their shareholders would also be required to set aside money that would reimburse the fund if the Department of Forestry and Fire Protection (Cal Fire) determines that the utility is responsible for the wildfire, i.e., PG&E would have been required to reimburse the fund for amounts expended in connection with the Camp Fire for which Cal Fire determined PG&E to be at fault.

The fund would be overseen by a Catastrophic Wildfire Victims Fund Commission[6] within the Department of Insurance what would determine the amount of funding that the utility is required to set aside. The Commission is also permitted to issue bonds against the fund and may purchase reinsurance for the fund. Beyond these basic parameters, AB 740 is short on detail, leaving quite a bit of discretion to the Commission and uncertainly for PG&E as it looks toward a plan of reorganization.

The wildcards

If AB 740 becomes law, then any Chapter 11 plan for PG&E will need to take account of the funding that is required to be set aside to reimburse the Catastrophic Wildfire Victims Fund. This could be a significant amount of money that could affect the waterfall under the plan. But, PG&E’s wildfire funding requirements are not the only wildcard impacting PG&E’s future and exit from bankruptcy. As the Strike Force noted in its report, the reorganized PG&E may look very different from pre-bankruptcy PG&E. Although the Governor has not advocated municipalizing PG&E’s operations or breaking up the company at the current time, these options are still on the table.

Another wildcard for PG&E and what may prove to be the biggest challenge the company faces during its bankruptcy is reaching a consensus among each of the interested parties in the case. Debtwirerecently reported that Governor Newsom has been working behind the scenes to work out a settlement that would include claims from wildfire victims. This may be easier said than done. The tort committee for one has consistently opposed much of the relief requested by PG&E in its bankruptcy case and has indicated that it will not support a plan that provides for anything less than payment in full of wildfire claims. The tort committee believes that those claims total USD 42bn (USD 30bn in tort claims, USD 10bn in subrogation claims and USD 2bn in public entity claims). PG&E has said that this number is closer to USD 30bn and a recent report indicated that PG&E is discussing a potential USD 11bn capital pool with legislators to settle wildfire-related claims. Many others are likely to weigh in before all is said and done. Whether Governor Newsom is successful in brokering a settlement among the parties or whether Judge Montali ultimately settles the issue after an estimation hearing remains to be seen. Regardless, capping the wildfire claims could prove to be a lengthy, contentious and expensive process.

Finally, and what is perhaps the biggest variable for PG&E and all involved is the threat of another massive wildfire hitting Northern California during the course of its bankruptcy case. Another destructive wildfire brings with it the potential for massive administrative claims blowing up the waterfall, which could render PG&E administratively insolvent and incapable of confirming a plan of reorganization.[7] A catastrophic future wildfire could also deplete a wildfire victims fund, leaving the utility, shareholders and wildfire victims in the same position as they were immediately prior to PG&E’s bankruptcy. Thus, any plan or legislative solution for PG&E must involve all parties and take account of all contingencies.

Sarah Foss is a former practicing restructuring attorney. Prior to joining Debtwire as a Legal Analyst, Sarah practiced in the New York and Houston offices of Winston & Strawn LLP and Dewey & LeBoeuf LLP in the area of business reorganizations, including complex Chapter 11 cases and out-of-court restructurings. She has represented large corporate debtors, creditors’ committees, secured lenders, distressed asset acquirers and investment banks across a broad range of industries.

Any opinion, analysis or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice and subscribers should consult with their own legal counsel for matters requiring legal advice.

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Endnotes

[1] The bankruptcy court denied the appointment of an official committee of ratepayer claimants and an official committee of public entities with claims against PG&E.

[2] There have been nine objections thus far to the debtors’ bar date motion and proposed proof of claim form. A hearing is set for 26 June.

[3] PG&E Corp.’s board of directors can be found here and the utility’s board can be found here. PG&E plans to expand its board to 15 members, a proposal that will be voted on during PG&E’s annual shareholder meetings on 21 June.

[4] The catastrophic wildfire fund may also include the following elements:

Pooled capital from all California investor-owned utilities;

A trust to administer claims;

That the fund would only apply to catastrophic wildfires;

Automatic access to the fund regardless of whether the CPUC has determined that the utility acted prudently, reasonably, or without negligence; and